Microsoft Life?

Ironically, just a few days after writing my other post, imagining that after a rough summer, with lots of media drama around Second Life and Linden Lab’s ever-annoying attitudes to frustrate their userbase more and more, we would enter a period of relative calm until Christmas (when LL is supposed to start announcing the grid-wide implementation of meshes and Display Names), the SLogosphere was suddenly shaken up with the interesting rumour that Microsoft might be buying Linden Lab (some sources even think that this might already have happened, and that both companies are just stalling their joint announcement). Both Microsoft and Linden Lab have declined to confirm or deny the rumour.

The fun bit about the rumour was how it was spread. It was started by the notorious hacker and Woodbury griefer Tizzers on Twitter, who didn’t even post any sources for the rumour, nor even any follow-up messages. For some unfathomable reason, this simple message gathered the attention of some blogs and e-zines, some of them actually quite reputable. As soon as it was picked up by them, others started to cross-link to the original message. Tizzers was promoted as being “closely in contact” with Linden Lab; how that bit of misinformation popped in I have no idea.

Some of the more serious e-zines, part of reasonable large publishing houses, actually tried to get in touch with Microsoft to comment. ZDNet created an interesting article noting that Microsoft hasn’t done any acquisitions this year, so this might be their first one. All of a sudden, ex-Linden employees and even some actual employees have somehow “confirmed” that there was some truth in the rumour; somehow, a few were aware that there had been conversations among Microsoft and Linden Lab.

Now where did all this come from? Tateru Nino, who usually gets her facts right, has a more reasonable explanation. And this requires a bit of delving into corporate tactics…

I must say I love to spread rumours too 🙂 It’s a fun exercise. For my April Fool’s articles, which have often unpredictable consequences, I use always the same trick: start with a few verifiable facts, re-interpret them in a new way, and add a simple “white lie” which could be true (i.e. it has to be plausible). People will often check on the facts and find them to be true and correct, and thus be lead to accept the whole article as genuine — a typical fallacy. For instance, an announcement that Google would have a research division on the Moon is utterly unbelievable because nothing can be verified. A more clever announcement would be that Google’s Page & Brin would partner with Richard Branson to supply Virgin Galactic‘s future orbital data centre — the media knows that Branson is insane, but he does own a company that does sub-orbital space flights, and together with Google, they would have money enough to build a space station (if ordered to the Russians, it would cost merely US$ 1 billion — cheaper than what Google paid for YouTube in 2006). So that kind of “news” would be plausible and parts of it could be validated.

This rumour about Linden Lab’s sale to Microsoft has undergone similar strategies. Journalists reporting on this have correctly claimed that LL was closing offices in the UK (which is not “news”; it was announced a couple of months ago, but it’s an useful factoid to “revive” for the unsuspecting audience); they have connected Woodbury’s Tizzers to Linden Lab (quite a feat, but there are certainly a few articles about LL’s reaction to the Woodbury griefing that can be located on the net, and this would establish “a connection”). They assume that the leak originated from Linden employees, or, more believably, by disgruntled ex-Linden employees (people can validate that a lot of employees were fired, and immediately “believe” they would be disgruntled). And, of course, Linden Lab is VC-funded like pretty much every technological company in the US, and a good journalist is aware that, sooner or later, shares held by VC partners will be sold out (more on that later). Then, fortunately for the journalists, both Linden Lab and Microsoft have neither denied nor confirmed the rumour, which adds to its credibility — a straight denial by both companies would bury the rumour immediately.

So put all this together in a package — some journalists added a few more verifiable factoids to conjure up more credibility; I address ZDnet’s case below — and you have a “believable” rumour, because parts of it can actually be verified and validated and found to be true, even if they are irrelevant. And the whole rumour in itself wasn’t explicitly denied — so it means it could be true. Get enough media to crosspost, let journalists watch the blogs and the social media networks finding hundreds or thousands of people writing about the very same issue, and the rumour spreads like wildfire. I have to take my virtual hat off to Tizzers; I never managed a fraction of the success with my own story that Google had bought Linden Lab, and, in my not-so-humble opinion, I had far better arguments back in 2006… I guess that to spread a good rumour you have to be a great hacker and known griefer, and I’m neither 🙂

Anyway… first of all, let’s assume, for a moment, that the rumour is actually true (I’ll address later the issues that I personally have with it). If so, no matter how much a journalist might pester Linden Lab and/or Microsoft, they wouldn’t answer to them. A message neither confirming nor denying is usually the standard routine. Let me explain why.

Last year, Business Insider valued Linden Lab at US$ 800 million. Obviously this is just a number based on observation of estimated profits and the userbase, as well as positive media exposure. Linden Lab is a private corporation, so they’re not required to publish their numbers. I would even venture so far as to admit that the people at Business Insider might not have thoroughly analysed Second Life’s numbers — which are published every quarter — and, based on those, you can roughly estimate how much LL makes. It’s a popular pastime of many residents, trying to figure out how much profitable LL actually is. Since the numbers have the same source (the SL economy) they are usually around the same range. Based on that, we can estimate the following: Linden Lab’s owners might be willing to either sell a share of it (like Facebook did) and get a new partner, or sell everything and cash in.

LL’s funding partners have invested, until 2006, around US$ 11 million (these are the public numbers we got). Based on that, we know that typical venture capital companies want to recover at least ten times of what they have invested, after a decade. the timing is about right. If we assume they own 10% of LL, they would wish at least to get US$ 100 million back, and that would value LL at around US$ 1 billion. Typically, VC companies and business angels expect to invest in ten companies, have seven of them utterly fail, two doing well enough not to lose money, and strike gold on the last one — selling their share of it for the amount they’ve invested in all ten. It’s like gambling, but legal: you bet on a dozen companies, hoping that one pays off. LL is probably one of the very few of those that might “pay off” — if they find a willing buyer.

Now, LL’s VC funding partners have not sold their share of LL yet — we can see that from their corporate website — so it’s quite reasonable to expect them to say: “We have been with you for over a decade. You guys are one of the rarest things on Earth: a profitable Internet company with a solid business model. We’re very happy. Now we want to recoup our investment and put the money elsewhere”. This is standard routine for a VC company; all work pretty much the same way.

Since LL is not a public company, everything is handled discreetly. As soon as some media start hinting at the value of LL, it’s reasonable to admit that the VC partners of LL might have started to get in touch with potential buyers. They have great arguments. They could say they had a share worth US$ 100 million and tell potential buyers that, thanks to LL’s reasonable profits (estimated at around US$ 50 million annually — some people, including Hamlet Au, have come up with this number based on tier prices and commissions on the LindeX; and we also know how many employees LL has, and how many of those are developers, so we can also estimate labour costs. Office lease costs is also easy to calculate based on what real estate websites show in the area around LL’s offices), a potential investor would get their money back quickly enough. After at least half a decade of profitability, LL can make a good point of having a solid business model, and some investors will look less at the media exposure and more on the real numbers.

So after a while, the VC companies might bring up a selection of potential candidates. In some cases, they might require the approval from LL’s Board to sell their share (say, LL’s Board might not be interested in partnering with a direct competitor). In other cases — and nobody knows how the share distribution is at LL; the VC companies might own the majority of the company’s shares, although this is rare (10-30% is usual, more than that would be very strange indeed) — they might just inform who the new owners of their slice of shares will be.

Let’s assume that they have a short list of 3-5 potential buyers (Tateru and others consider even that they might have had a dozen offers or more). What happens next is that this list gets ordered by priority, and a period of negotiation starts: both LL and the potential buyer enter an agreement of exclusivity during the negotiation phase. What this means is that the potential buyer will now be able to perform due diligence on LL (i.e. look at their accounting…) without fear that another potential buyer might grab the deal under their feet. During this period, both companies shut themselves off from the media and sign mutual NDAs. Nobody is allowed to talk about the negotiation. Other potential buyers are told to wait; LL will not reveal to anyone who is on that list, not even to the potential partner currently under negotiation. Usually, this phase lasts a few weeks: the potential buyer has to understand the nature of the business from inside (not from wishful thinking based on media reports!), but LL doesn’t want them to take too much time, because they might drop the offer, while others on the list might have better ones.

In some cases, an initial bid is requested, and LL might order the list according to the highest bidder, and negotiate the price afterwards. In other cases, LL might request a payment to move up to the list, if there are a lot of potential buyers. There are some negotiation variants at this stage, but the important thing to remember is that it will all be secret. That’s one of the huge advantage of never going public, you don’t need to reveal anything to the general public at all, and this also includes the media: journalists can beg, speculate, and be creative about what they write, but when a privately held company is being sold, nobody has a clue until the process has been completed.

And all employees — even the ones leaving the company — are under NDAs as well. They won’t “leak” anything (and most of the time they will be kept in the dark anyway) for fear of getting heavily sued!

This negotiation might actually have started early in 2009. Like Tateru reports, it’s highly likely that nobody wanted to pay a price acceptable to what LL was expecting. LL is actually in a complex situation: investors love tiny, cheap, and very popular Internet companies, grabbing them when they’re young and still inexpensive but already rocking the media. When they grow to a certain size, like Facebook for example (or YouTube when Google bought them), they become harder to estimate. There are plenty of ways to estimate companies, and each arrives to completely different numbers. Interestingly enough, the dot-com era brought a new way to estimate them: based on media hype, which is the most unrealistic and senseless way to estimate a company…

That’s why the bubble burst. Ten years later, companies are still getting evaluated that way! Most investors never learned the lesson. And as a side-effect, journalists, as the providers of speculative hype about a company, have a much stronger influence in the negotiation process, which is completely insane: instead of trusting an accountant or financial consultant to estimate how much a company is worth, investors believe more in journalists… and rumours spread by hackers and griefers!

It’s a strange world.

But that doesn’t mean that the rumour might not have some grounds for actually being true…